Dear Mr. Buchan:
My wife, children and myself are all shareholders in your company, and in light of the recent accounting and Enron scandals, I would appreciate answers to certain questions concerning your company’s hedge book as a whole, and the specifics of each individual hedge transaction. Your present reporting does not detail these key items that are critical to an investor’s ability to calculate the risk factors of investment in your/our company.
What percentage of the funds that you have taken into earnings or deferred earnings (originating from your hedge transactions in the past five years) are free from the necessity of maintaining your present hedge position?
In derivative contracts with derivatives dealers, does the right of "offset" exist? That means, should the dealer enter insolvency while owing money to us, can we charge that indebtedness against what we may owe the dealer?
Have we dealt with a well-known substantive investment or commercial bank, or with a subsidiary of that entity? If the answer is a subsidiary of the investment or commercial bank, in what nation is the subsidiary domiciled? What are the legal/capital/bankruptcy laws of that domicile? This information is necessary to assess real credit risk.
Is the subsidiary of the investment or commercial bank entitled to an automatic fund forwarding from the parent to cover the "Trade DEBT" of that subsidiary, if the subsidiary fails? If not, then we would have to cover the failed commitments, as margin calls do not wait for litigation outcome.
If we have dealt with a subsidiary of the investment of commercial bank, have you seen the balance sheet of that subsidiary and audited amount of total nominal value of derivatives granted by that entity to others? Without this, no reasonable calculation can be made of our credit risk involved with this dealer.
If we have dealt with a substantive investment or commercial bank in hedge derivatives, has our Board of Directors been apprised of the condition using an audited statement of the nominal value of all derivatives granted by that institution? If we have not, then regardless of the hundreds of million or billions in capital that these above firms have, no meaningful qualification of risk hasbeen (or can be) made.
Can we trade the entire transaction of the hedge book with any dealer we wish, or are we obligated to one "granting dealer" when changes or closure are required or desired? If we can’t take our position in totality (or leg by leg) to any dealer, we have severely limited our liquidity and tied ourselves to the financial condition of our counter-party.
Assuming we used leased gold contracts as part of our hedging program, do either ourselves or the dealers have the obligation of returning the gold, re-leasing the gold or replacing the gold at the end of the standard term of lease (which is one year) required by all central banks? Does our Board of Directors realize that no matter what our contract says with the gold bank, the leased gold needs to be re-leased, replaced, or covered at the end of each year regardless of the fact that our hedge position may go out as far as ten years forward?
Regarding the hedge instruments: a) Were all the trades transacted over-the-counter, or on a listed exchange? b) Is there a regulatory body presiding over all these transaction? c) Are the prices of these instruments in the public record somewhere? d) Was the price of these instruments determined by computer modeling? e) Is there an open market for each leg of these hedge transactions?
Regarding legal consideration: a) Are you familiar with the legal precedent set in the early 1990’s in the Southern District of Manhattan Federal Court whereby the validity of a derivative transaction is determined by the capitalization of a transaction versus the nominal value of the transaction? b) Are you familiar with the legal precedent concerning the validity of a commodity transaction being determined by the timely (and industry standard) execution of a margin call?
I would appreciate prompt answer to these questions, as without this knowledge, no responsible conclusions can be gained concerning the actual risk our company has, regardless of our company’s position in the industry, or the size of your treasury. If you have not reviewed all the criteria of the individual hedge contracts, dealer’s stability by documentation, and freedom to deal for closure (by individual leg or by total spread position) with any dealer of your choice, I would feel you are not fulfilling your duty to us, or any other shareholder.
Thank you for attention in this matter.
Yours very truly,
Edward Steer
7010-21 Avenue
Edmonton, Alberta T6K 2H4
Phone: 1-780-450-0821
e-mail: edsteer48@hotmail.com
cc: Brian W. Penny
V.P. Finance and C.F.O.
File (1)
Eight days later, on March 27th, I received a personal e-mail from C.E.O. Robert Buchan (with a CC to Brian Penny) regarding my letter. It said "We have received your letter, and your questions are certainly of a calibre that we are not used to seeing. Since we are currently in the final throes of completing our regulatory filings, no one is currently available to respond to your letter. I expect that by next week we will be in a position to have someone spend the time and properly answer your questions. However, I can indicate to you right now, that there are no issues of concern raised by your queries. A fuller explanation will be forthcoming soon." Regards, Bob Buchan. (emphasis added is mine)
True to his word, on April 4th, the following letter arrived from Christopher Hill, the Treasurer of Kinross. I have included every word below:
04 April 2002
Dear Mr. Steer
I am responding to your letter to Mr. Robert Buchan dated 19 March 2002. I will respond to the questions in the order they were given.
All of the funds we have recognized as revenue or deferred revenue that originated from our hedge transactions are free from any necessity of maintaining our present hedge position. There are no covenants in any of our trading agreements or credit facilities that require us to maintain a hedge position.
Yes, we have the right to "offset" as part of the hedge agreements we have with dealers.
We have dealt with only highly credit rated counter parties. We have not dealt with subsidiaries of those institutions. The counter parties we are dealing with are domiciled in the United States, Canada, or the United Kingdom, and the contracts we have entered into are either based on Ontario law or New York law.
This question is not applicable, as we have not dealt with subsidiaries.
This question is not applicable, as we have not dealt with subsidiaries.
The Board of Directors reviews all hedge transactions on a quarterly basis. The notional (or nominal) amount of the hedging transactions is reviewed, as is the current gain or loss of those positions.
We are under no obligation to transact any portion of our hedge book with any dealer. The instruments we use in our hedge book consist of "plain vanilla", readily available, liquid products that can be bought or sold to a number of dealers. We can enter into a position with one dealer and close it out with another.
I don’t believe this statement is correct. There are no standard terms for leasing gold; lease terms can be for 3 months or for 5 years depending on what terms have been struck between the central bank that is lending the gold and the dealer that is borrowing it. As far as our contracts are concerned, as at December 31, 2001 we have some hedge contracts that are for terms greater than one year. In those cases, it is the dealer’s choice to fund that gold lease either with a term that exactly matches our liability with a lease of shorter duration, the risk of re-borrowing the gold rests solely with the dealer.
All of our gold hedges are transacted over-the-counter. There is no regulatory body that presides over the transaction. The prices of these instruments are not in the public record anywhere. The price of these instruments is often determined by computer modeling. We gain assurance that the price we are receiving is fair by purchasing real time data which allows us to model the transactions ourselves, as well as getting several quotes and taking the best price in the market. There is not an open market for each leg of these hedge transactions, however we believe the liquidity in the over-the-counter market for the transactions that we enter into is more than sufficient for our needs.
We are not aware of the legal precedent set in the early 1990’s in the Southern District of Manhattan Federal Court. We do not know if this precedent applies to any of the transactions we enter into or not. We do retain legal counsel to review and comment on all of the legal trading agreements we enter into with counter parties for the purpose of hedging, and we heed their advice. None of the trading agreements we have entered into allow for margin calls. We do not anticipate entering into any agreements that require margin calls.
I hope this puts to rest any concerns you may have about our hedging program. Hedging is an important management tool in helping us to shield the company from the volatile price changes that can occur in the gold market. As in the past, we expect to prudently use this tool to help Kinross maximize the gold price it realizes each year. (emphasis added by the author)
Sincerely,
Christopher Hill
Vice President, Treasurer
Kinross Gold Corporation
I certainly appreciate the fact the Mr. Hill took the time to reply in such detail to my questions. Unfortunately the same cannot be said for the management of Durban or Newmont who didn’t even bother dignifying my registered letter with a reply of any kind.
But having received this reply from Kinross, I thought no more of it until May 2nd when two things occurred simultaneously on that date. The first was a new essay by Harry Schultz and Jim Sinclair that was published on The Matisse Table at LeMetropoleCafe. In it was an essay entitled "The 30 Billion Dollar Not Sure Thing" regarding "the unique and weak character of the vehicles used for hedging by the majority of gold producer of 100,000 ounces per annum and up."
Harry and Jim went on to say that "A so-called "balanced" hedge book carries with it in today’s world an enormous risk to the hedger. That risk is the counter-party risk."…."Spreading your business to many gold banks is no protection from a potential melt-down of the derivative vehicle because it will be an industry-wide phenomenon when it happens"….."We close by reminding our industry colleagues that those pieces of paper they hold so close to their hearts are promises to pay which total $30 billion. Should gold trade at $354, we for professional and knowledgeable reasons, stake our reputation on the following. THEY WILL NOT PAY!"
It’s a pretty safe bet that the information from both these Harry Schultz essays was all over the gold world the moment they went up on his web site.
The second thing that happened on May 2nd was Kinross’s press release that they intended to pay out their hedge position, from which I quoted at the beginning of this essay.
If you re-read the e-mail I got from Bob Buchan, paying particular attention to the one sentence that is in bold type, you may wonder what happened between the time he sent that e-mail to me on March 27th and their announcement on May 2nd. I certainly did.
Then if you go back and read the letter I got from Mr.Hill, and you look at the first sentence of item 3, and all of item 9, plus the last sentence in bold type, I think it is pretty clear that with the kind of enquiries that Kinross was getting from both myself and others on this matter, that top management and the Board of Directors (probably already nervous) decided that discretion was the better part of valour, and pulled the hedging plug.
Most of these "counter-parties" that miners such as Kinross use, are the "usual suspects" in the gold world. With their names up in lights virtually every day for one indiscretion after another, it was no secret that other hedged gold producers were looking at them sideways and were starting to head for the exits themselves. These "counter-parties" now have problems in other financial areas such as interest rate and currency derivatives, and if you’ve read Doug Noland’s latest work (May 3rd) at www.prudentbear.com you will see that these entities have serious problems everywhere you look. Gold is just "another brick in the wall" for them, but it’s a very BIG brick! Counter-party risk, and financial systemic risk now lurk around every corner these days.
Only time will tell if Kinross "found religion" in time or not. Other companies, such as Durban, announced their intentions to get unhedged some time ago, and are doing just that. Not all will be "saved" when "judgement day" arrives, but the rush for "salvation" is well underway.
For the heavily hedged gold producers such as Anglogold, Newcrest, Sons of Gwalia, Placer Dome, and that "Darth Vader" of gold companies…..Barrick Gold……who are hedged years worth of production; no amount of "holy water" or any of that "old-time religion" will save them from a gold price melt-up, or a gold derivatives melt-down…..or both.
May their shareholders "rest in peace", I just hope I’m not going to be one of them!
Ed Steer
Edmonton, Alberta |
